Oil Is at the mercy of Financial Markets

The trajectory and health of the global economy has moved to the top of the list in terms of variables exerting influence on oil prices

Oil prices regained more ground on Wednesday, pushed higher after equity markets rebounded from an initial selloff at the start of 2019 trading. The price gains are not entirely convincing. WTI and Brent posted strong gains, each up more than 3 per cent by midday in New York, but come largely after U.S. equity markets shook off an earlier bout of pessimism.

In fact, the trajectory and health of the global economy has moved to the top of the list in terms of variables exerting influence on oil prices. On any given day, stock prices offer a clue into investor sentiment in this regard. Energy markets are following lockstep with what the equity markets are doing here, and I think that's going to continue to be the case, Brian LaRose at ICAP Technical Analysis, told Reuters.

There were not a ton of new indicators to offer further insight into what to expect in early 2019. The most recent piece of data came from China's factory activity, which showed a contraction in December for the first time in two years – not exactly a positive signal.

The manufacturing survey data out of China this week is particularly negative for crude oil, as it goes to the heart of the key demand center for the market, said John Kilduff, a partner at Again Capital Management, according to Reuters.

On the other hand, just a few days ago, President Trump and Chinese President Xi Jingping apparently had a lengthy phone conversation in which they made progress on the trade front. Xi told Trump in a that he had hopes that both teams can meet each other halfway and reach an agreement beneficial to both countries and the world as early as possible, according to Xinhua. Trump followed that up in a tweet, stating that a deal is moving along very well, one that covers all subjects. Big progress being made! Trump said.

A thaw in the trade war could relieve one of the global economy's major headwinds for 2019.

Oil traders also took heart in news that Saudi Arabia is following through on major oil export reductions. In December, Saudi Arabia slashed oil exports by roughly 500,000 bpd, according to Bloomberg. However, it could be some time before these cuts show up in the inventory data.

Inventory draws as a result of cuts by OPEC+ may not be so easily visible for a while but avoiding a steep inventory increase in H1 2019 is what the market needs to see, Bjarne Schieldrop, chief commodities analyst at SEB, said in a statement. There will be a several-month lag before the OPEC+ cuts start to be felt by the market. Oil producers have to first lower output, then there will be a corresponding effect on inventories.

However, the cuts may not be large enough to induce large reductions in storage levels. Instead, inventories may merely stabilize, Schieldrop said. On top of that, the IEA reports OECD inventory data on a two-month lag, so data for January won't be available until March. However, one month's worth of data may not tell us much, so the market may have to wait until April or May to get a sense of how the OPEC+ cuts are affecting the global supply balance.

There will also be a lag in terms of a potential shale drilling slowdown in response to lower prices. During the last downturn, the reaction from the rig count data came at least six weeks after major oil price movements. As such, the recent meltdown in oil prices, which began back in October, may only now start to show up in the weekly rig counts.

At the same time, the EIA just released monthly U.S. oil production data, showing a jump in output in October to 11.537 million barrels per day (mb/d), up from 11.458 mb/d a month earlier. It was another solid increase in output, although to be sure, it was a fraction of the monthly increases for much of 2018.

Oil traders are still awaiting more definitive clues about the supply/demand balance, but volatility is likely to stick around for a while. In the short run, oil prices will likely follow global stock markets up or down on any given day until the fundamentals reveal a more discernible pattern.